Small Business Insights

Recently, Dan Drechsel wrote a guest blog article on Small Business CEO.  Below is an excerpt.  To view the entire article, please go to http://www.smbceo.com/2010/11/29/bad-habits-funding/

By Dan Drechsel

It’s common for small businesses to slip into bad habits that limit their ability to get funding.  From unscreened customers to generous payment terms, here are some of the most common reasons lenders will not loan to small business owners.

1. Not putting profits back into the business

When you hear these pleasant words from your accountant, “You should take a draw before the end of the year,” think again.  Building equity in your business has a positive impact on your ability to get funding.  A lender always looks at your debt-to-equity ratio.  The more equity you have, the better your ratio.  If you believe you will be able to grow the business next year, and will need financing to make it happen, manage your debt-to-equity ratio as carefully as you manage your personal taxes.

Good habit:  Keep your business solid by re-investing to support growth.

Check out Dan Drechsel’s entire guest blog article by visiting: http://www.smbceo.com/2010/11/29/bad-habits-funding/ on Small Business CEO.

By Jeff Guldner

Often, small business owners will ask why lenders require them to sign a personal guaranty, especially when the lender also requires the business to pledge all or substantially all of its assets as collateral. The reasons are somewhat inter-twined, but the short answer is that it is a function of risk and the fact that most small businesses are also closely held and controlled.

As a rule, small businesses are riskier ventures than large businesses. In fact, the failure rate and default rate of a business increases as its size decreases. Said another way, size does matter. This is one reason why the lender will require a backup or secondary source of repayment in the form of a PG.

Another reason is that the small business is often closely held by one person, a family or several partners and is therefore simply an extension of the owner(s) and their lifestyle. The owner has absolute control of the business, being able to affect all decisions that impact the success or failure of the company, including strategic direction, policy making, management, capital structure, asset sales, liquidation and owner’s compensation. A PG is a show of confidence by the owner that the decisions being made are with an eye toward being sound financially and with the interests of creditors also in mind.

Finally, when a small business is no longer viable, the lender and other creditors are more likely to be repaid if the owner remains actively engaged in the orderly wind down or liquidation of the business. The owner can maximize asset sale or liquidation values as opposed to “throwing the keys to the bank.” The lending community often refers to this phenomenon as “aligning the interests of the owner with those of the lender.”

A logical follow up question is what needs to happen to negate the need for a PG in a small, closely held business. The short answer is that it probably won’t happen as long as the business remains small and closely held, given the reasons above. However, at some point lenders will not require a PG and factors influencing this decision are not only size and ownership structure but also the financial wherewithal of the company, collateral coverage, and depth and breadth of the management team. While not a true substitute for a PG, lenders may rely on financial and other covenants, as well as, asset based lending arrangements to control their lending risk. It is generally accepted in the marketplace that lenders will require PG’s on all closely held businesses and that getting a lender to move off this requirement becomes less likely the smaller and more closely held the company is.

To summarize, PG’s will be required from the controlling owner(s) in most all cases where you have a small, closely held business for the simple reasons that smaller businesses are generally riskier than larger ones and that the small business is considered an extension of the individual controlling it and therefore that person should be financially responsible for it. In the event the business suffers financial distress or fails, the continued involvement of the controlling owner in facilitating an orderly wind down or liquidation of the business generally results in a more favorable outcome for the creditors.

*A personal guarantee is an unconditional promise to pay, made by the individual owner, in the event of default or the inability to pay by the business.

Jeff Guldner has over 30 years of experience in credit risk assessment and management for major lending institutions. Guldner is the Chief Credit Officer for Ftrans. Ftrans combines accounts receivable management with affordable access to funding – providing small and medium-sized businesses the cash they need to take advantage of market opportunities and grow.

Consider this:

Surviving in today’s economy is dependent upon one thing: getting paid.   Many small to mid-sized B2B companies are failing not because of a decline in sales, but because they do not have the cash-on-hand to survive if their customers fail to pay. In this economic climate, business owners have to plan for the worst in terms of their own finances, as well as take their customers’ financial situation into consideration.

It generally takes a small business 56 days to get paid by its customers. For a company selling $20,000/week, that’s eight weeks of sales outstanding, which equals $160,000 in untouchable assets. What would the difference be for a company of this size if, instead of risking that amount, it could have guaranteed access to 90% of that capital within 3-4 days rather than 7-8 weeks?

The economic crisis has affected almost every sector of the US economy but there are a few steps B2B companies can take to protect their businesses from losing money this year.  Business owners should take into consideration the credit worthiness of their customers before making sales and have a backup plan in place to prevent a loss in revenue from buyer bankruptcy. In today’s market, it’s important to understand the consequences of the business relationships keeping a company afloat and although it’s possible for companies to grow under these circumstances, having an added layer of protection certainly helps.

One increasingly popular way for SMBs to protect themselves from being subject to a customer’s failure to pay is by AR Outsourcing.   Here’s some background on how AR outsourcing works and the implications it could have on the health of a company:

Know Who Your Customers Are

Business that use AR outsourcing should implement an underwriting and credit verification process before verifying invoices so that businesses immediately have a transparent look into the creditworthiness of their customers. As a business owner, having this insight helps you avoid selling to someone who might not pay on time – or at all.

A business’ credit management provider should also maintain an ongoing credit monitoring system with its customers to help establish a credit policy that includes trade credit limits and payment terms. Having an understanding with customers about the extent to which you will lend helps ensure a healthy business relationship and protects against unpaid invoices.

Put the Burden on Someone Else

Similar to a B2C company accepting a credit card for payment, AR outstourcing puts the invoicing burden on the credit provider. By working with financial institutions, the credit management vendor borrows against your AR, takes on the debt and provides you with the capital upfront. In some instances, businesses get paid in as few as four business days, which eliminates the hassle of slow paying customers while also increasing a business’ cash-on-hand.

Businesses Have More “Insurance”

By outsourcing AR, businesses are often guaranteed a certain percentage of each sale, thus providing “insurance” for their invoices. In addition, in the event that a customer does go bankrupt, the business is protected and will still get paid. For certain credits, credit insurance backs each sale for up to 90-100% of the amount of the sale made.

By: As founder of FTRANS, John B. Hayes brings over 30 years of experience in developing technology-based companies that help businesses manage their finances.  John was also co-founder and president of the company that built Peachtree Software products, the first microcomputer accounting software.  He recently published a book entitled, “Use the Credit Crisis to Grow Your B2B Business: A Proven Strategy for Enduring Competitive Advantage and Business Growth, Especially in Times of Crisis or Recession.”

 Ftrans combines fast and affordable access to funding professional with receivables services – providing small and medium businesses the business line of credit they need to grow and take advantage of market opportunities.  Liberating you from funding challenges and receivables hassles.